Jonathan Macey on Director Capture

Jonathan Macey is one of the "Big Dogs" of academic writing in corporate governance. He is the Sam Harris Professor of Corporate Lay, Corporate Finance, and Securities Law at Yale (and Deputy Dean of the Law School. He's written a boatload of books on the topic, and over a 150 articles in scholarly journals. In this piece (where he's guest blogging at the Icahn Report, he discusses the concept of "regulatory capture."

In the academic world, particularly among political scientists and economists, "capture" occurs when decision-makers such as corporate directors favor certain vested interests such as incumbent management, despite the fact that they purport to be acting in the best interests of some other group, i.e. the shareholders. The problem of capture and the theories associated with the idea of capture are most closely associated with George Stigler, and the free-market Chicago School of Economic thought. Among the more interesting and important theories of Stigler and other proponents of capture theory is the idea that capture is not only possible, in many contexts it is inevitable.

Read the whale thing here

Connections, Networks, and Investment Managers' Performance

One argument for going to a top school is that you get to tap into the alumni network and make connections with classmates that will help you in future years. Here's some interesting evidence that it's true in the investment world. Cohen, Frazzini, and Malloy examined how school ties affected the investment patterns of mutual fund managers in a paper, titled "The Small World of Investing: Board Connections and Mutual Fund Returns." They examined whether mutual fund managers invested differently in a company when someone from their school sat on the board. They found that:

• When the manager and the board member went to the same school, the manager took a significantly bigger stake in the company
• These "connected" investments gave significantly higher returns (a portfolio of connected investments outperformed non-connected ones by over 8% per year)
  
• The abnormal returns on connected investments were concentrated around corporate events such as earnings announcements.

Here's a copy of the paper.

It's a pretty interesting piece - it appears that they superior returns weren't merely a reflection of the managers knowing more about the ability of the board member. The most telling finding was that the returns were concentrated around specific news events. Hence, they were more likely to be driven by "inside" information.

All in all a paper worth reading (or at least, discussing in class).

Bainbridge - Boards In the News

Steve Bainbridge is one of the most prolific scholars in the field of corporate law. He has done quite a bit to advance his view of what he calls "director primacy". , he writes:

In brief, the director primacy model views the corporation as a vehicle by which the board of directors hires various factors of production. The board of directors thus is not a mere agent of the shareholders, but rather is a sui generis body - a sort of Platonic guardian - serving as the nexus of the various contracts making up the corporation. Director primacy thus claims that fiat - centralized decisionmaking - is the essential attribute of efficient corporate governance.

He goes on to discuss how the recent dethroning of AIG CEO Maurice Greenberg and elevation of Robert Iger to the top spot at Disney demonstrates how boards are increasinglyasserting their power.

Click here forthe whole post.


Of course, since the board acts as the agents of shareholders, there still exists a potential agency problem there. I'll be posting more on that in future posts.

How Independent are Independent Directors?

As a corporate governance researcher, I tend to see principal-agent relationships everywhere. One that has received a lot of recent attention is the one between directors and shareholders. One of the good things to come out of the recent corporate scandals has been a greater push for board independence. The Wall Street Journal has a good piece in today's paper on how the definitions of what makes an "independent" director may not do a great job of defining independence. Here's a snippet:

The New York Stock Exchange and the Nasdaq Stock Market imposed the rules in the past 18 months to boost the number of directors who have no interest in overseeing the companies they serve beyond looking out for shareholders. But a review of 150 corporate filings by The Wall Street Journal highlights how exceptions and qualifiers in the rules have, in the view of some critics, limited their effectiveness.

Coca-Cola Co. counts billionaire Warren Buffett as an independent board member, even though he heads a company that does tens of millions of dollars of business with the soft-drink giant. Citigroup Inc. deems two directors independent, even though they have children employed by the financial giant. At BB&T Corp., in Winston-Salem, N.C., an attorney whose law firm works for the financial-services holding company heads the board committee that sets executive pay -- one of about 20 instances of "independent" directors employed by the public companies' outside law firms.

The rules, which cover companies listed on the NYSE and Nasdaq, were in part a response to fraud scandals at Enron Corp. and other companies that highlighted the risks of directors with financial relationships to their companies. Critics see such ties as potential conflicts, because directors might be tempted to allow their own financial interests to override shareholders'.

For the whole article, click here (subscription required).

A very timely and creative related academic piece "Back Door Links Between Directors and Executive Compensation", by Larcker, Richardson, Seary, and Tuna just showed up on the SSRN. In it, they define a measure of "back door influence" that extends the definition of director interlocks (where director A sits on the board of director B's company and director B sits on the board of director A's company) in a very interesting way. Their measure is similar to the "degrees of separation" game where you try to see how many connections you must make to link any actor to Kevin Bacon (click here for the Oracle of Bacon at the University of Virginia). A direct interlock would indicate one degree of separation. If the directors are not directly interlocked, but instead both sit on a third company's board, they have two degrees of separation. If they sit on two unrelated boards that share a third director, they have three degrees of separation, and so on.

Interestingly they find that

"... CEOs at firms where there is a relatively short back door distance between inside and outside directors or between the CEO and the members of the compensation committee earn substantially higher levels of total compensation (after controlling for standard economic determinants and other personal characteristics of the CEO and the structure for board of directors)..."

Click here for the abstract.

UPDATE: Welcome to all the folks from Professorbainbridge.com -- thanks for stopping by.